Why Is Xiaomi Crushing Samsung and Apple in China?

Chinese smartphone maker Xiaomi has just surpassed Samsung (NASDAQOTH: SSNLF) as China's top smartphone maker, according to a recent report from Canalys.

Xiaomi shipped 15 million smartphones in China last quarter, up 240% from 4.4 million units a year earlier. Samsung shipped 13.2 million smartphones in China during the quarter, down from 15.5 million last year. Xiaomi now controls 14% of China's smartphone market, and recently became the fifth-largest smartphone maker in the world.

Xiaomi's Mi 3. Source: Xiaomi.

Chinese customers heavily favor domestic brands -- including Xiaomi, Lenovo, Yulong, Huawei, BBK, ZTE, OPPO, and K-Touch -- which together shipped 70.7 million units during the quarter and claimed 65% of the market. Samsung and Apple (NASDAQ: AAPL) , the only two foreign companies among the top 10 smartphone makers in China, shipped 20 million units and claimed 18% of the market.

Xiaomi doesn't expect its sales to peak anytime soon -- it plans to sell 60 million handsets this year and 100 million next year. That would put Xiaomi in striking distance of Apple, which shipped 150 million iPhones in 2013.

Let's take a deeper look at Xiaomi to understand how it rose above the saturated market of Android phones and became a disruptive threat to Samsung and Apple.

What makes Xiaomi tickMany American investors dismiss Xiaomi as just a Chinese knockoff maker that got popular by copying higher-end devices and selling them at lower prices.

Xiaomi CEO Lei Jun, who dresses like Steve Jobs in iconic black turtleneck and jeans, certainly isn't shy about copying Apple. His keynote presentations even end with the "one more thing" note coined by Jobs. Xiaomi's flagship devices, the Mi 3 and 4, are clearly "inspired" by Samsung's Galaxy S5 and Apple's iPhone 5s.

Xiaomi CEO Lei Jun (L) and Steve Jobs (R). Source: Latest.today.

But dig deeper, and the company's unique strengths emerge.

Xiaomi's global vice president, Hugo Barra, was the former vice president and spokesman for Google's Android division. Xiaomi cuts costs with a simple strategy of direct consumer sales, rather than brick-and-mortar or third-party sales. It sells its products at razor-thin margins, spends very little on advertising, and doesn't amass large inventories of phones prior to a product launch. Instead, Xiaomi sells small batches of the phones to boost demand and publicity, and to hedge its costs.

It equips its phones with quality hardware -- the Mi 3 runs on a 2.3 GHz Qualcomm Snapdragon processor, has 2GB of RAM, and a 13-megapixel camera. Its customized version of Android, MIUI, is just as impressive as versions from Sony, HTC, or Samsung. Most important, customers get a big bang for their buck -- the Mi 3 only costs around $230 unlocked in China, compared to $500-$650 for an unlocked Samsung Galaxy S5.

Why Xiaomi is killing its rivals in ChinaXiaomi's robust sales in China are also fueled by two other factors -- national pride and perceived price gouging by foreign companies.

Prior to Xiaomi's arrival, the Chinese smartphone market was saturated by low-quality Android devices masquerading as iPhone knockoffs. From that mess, a handful of domestic companies like Lenovo and Huawei launched phones that Chinese consumers could be proud of. However, Lenovo and Huawei couldn't match Xiaomi's prices when it launched its first phone in 2011, since Xiaomi built its business from the ground up to sell high-end devices at low-end prices.

An Apple store in Hong Kong. Source: Wikimedia Commons.

Chinese consumers also know that Apple sells its products at a higher price in China than in other markets. An unlocked 16GB iPhone 5s, for example, costs around 4,600 RMB ($746) on Taobao. On Apple's U.S. website, the same unlocked phone costs $649. While Apple might attribute that higher price to shipping costs and import taxes, the fact remains that Apple charges Chinese customers nearly $100 more for the same phone. The Chinese media loves to make these kinds of comparisons -- Starbucks, Audi, and Subaru all faced similar accusations in the past.

Since Xiaomi's products are both well received and affordable, it's no wonder that the company is crushing both its domestic and foreign competitors.

The Foolish takeawayIn addition to the Chinese market, Apple and Samsung should keep a close eye on Xiaomi's plans to expand into Indonesia and Brazil. Those moves indicate that Xiaomi is getting ready to take on Apple and Samsung in other markets besides China.

If Xiaomi breaks through into Western markets, a pricing war could ensue, resulting in cheaper high-end smartphones. While that would be great for consumers, it would be terrible news for Apple and Samsung, which are both accustomed to high-volume and high-margin sales. Xiaomi's victory over Samsung in the Chinese market could just be the beginning of the company's widespread disruption of the global smartphone market.

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